How Fundamental is Economic Data to Markets?

Economic data releases are watched closely by investors. The extent to which they offer valuable information is less clear cut, however.

Official statistics bureaux around the world frequently attempt to capture economic reality, with measures ranging from unemployment rates and GDP, to confidence indices and housing starts. Financial markets, for their part, are believed to reflect this supposed reality in the form of asset prices.

Below we examine 12 key US economic indicators and the effect each has on one of the biggest and most liquid markets in the world. The chart below – which compares the relative volatility of US 10-year Treasury note futures returns on announcement days, with their volatility on a regular day – suggests that markets respond significantly to some of these data releases on the day of the announcement.

Relative Volatility of Treasury Returns on the Announcement Day of 12 US Economic Statistics

Data to 19 March 2019. The relative volatility is the average for US 10-year Treasury futures since 1997. Error bars show the 95% confidence intervals for these values.

Yet markets do not respond to all of these data releases in the same way. Of the 12 measures shown above, nonfarm payrolls stands out as moving markets more than any of the other statistics. Reported by the US Bureau of Labor Statistics on the first Friday of each month, nonfarm payrolls counts the number of US workers employed, excluding general government jobs, private household jobs, employees of non-profit organisations and farm employees.

The greater emphasis that market participants seem to place on this statistic’s announcement should come as no surprise: employment data would appear to be a logical gauge of the health of the world’s largest economy.

Nonfarm payrolls hasn’t always been a highlight of the economic calendar, however. Sentiment towards different indicators has changed significantly through time. While nonfarm payrolls has been important over the past couple of decades, they affected markets less during the 1970s and 1980s, when measures of money supply dominated.

Similarly, only over the past 10 to 15 years does it seem that financial markets have really responded to Federal Open Market Committee rate decisions and associated commentary. These releases have gained greater traction amid a period of unconventional monetary policy, as the following chart shows.

This shift in opinion can be attributed to a change in the way that the Fed announces its policy. Prior to 1994, the Fed met irregularly and markets had to infer policy changes from the central bank's open market operations, which were largely centred on targeting money supply measures. From 1994, the focus moved to targeting funding rates, and the Fed started to meet regularly, with policy changes announced in their minutes.

Data to 19 March 2019. Relative volatility of US 10-year Treasury futures is estimated over 10-year rolling windows and the shaded areas show the 95% confidence intervals for these values.

At Winton, we question the significance that the economic and investment management orthodoxy places on these data releases. Many government-issued statistics are prone to large revisions, not least nonfarm payrolls. And the scale of changes to GDP releases are well known: one revision in Japan in 2015 miraculously averted a recession, as an initial estimate for a 0.8% drop became an annualised growth of 1%.

As the plots above show, the market’s opinion of each measure varies and this opinion also changes through time. Investors must contend with a steady stream of economic data releases, which include various and, at times, conflicting indicators of economic growth and inflation. With such uncertainty in the data, deciding how to incorporate the information from these releases into an investment strategy is far from trivial.